When investing, it?s always useful to think about what?s priced in with a stock.
If the market?s expectations for a stock?s future growth in its business fundamentals is, in your opinion, overly pessimistic or optimistic, then this sets up a potential investing opportunity.
With this in mind, I?ve built a simple reverse-engineered discounted cash flow (DCF) model to figure out the implied growth rates for the free cash flows of the blue chip stocks Singapore Telecommunications Limited (SGX: Z74) and Singapore Press Holdings Ltd (SGX: T39).
When investing, it’s always useful to think about what’s priced in with a stock.
If the market’s expectations for a stock’s future growth in its business fundamentals is, in your opinion, overly pessimistic or optimistic, then this sets up a potential investing opportunity.
With this in mind, I’ve built a simple reverse-engineered discounted cash flow (DCF) model to figure out the implied growth rates for the free cash flows of the blue chip stocks Singapore Telecommunications Limited (SGX: Z74) and Singapore Press Holdings Ltd (SGX: T39).
Both companies are considered to be blue chips because of their billion-dollar market capitalisations and status as one of the 30 components of the Straits Times Index (SGX: ^STI).
To get a reverse-engineered DCF model to work, here are the inputs we’d need:
- Current price of a stock
- The stock’s free cash flow per share over the last 12 months
- A discount rate
- A terminal growth rate for the company’s cash flows
The first two figures are pretty straightforward and they’re given in the table just below:
As for the discount rate, I’ll keep things simple and use a hurdle rate of 15%. A hurdle rate is essentially the rate of return an investor will require from his or her investment. Bear in mind that a more academically-accepted version of the discount rate takes into account a wider host of factors such as the rate of return on a risk-free investment and the historical volatility of a stock.
Coming to the terminal growth rate, it is how fast a company will grow its free cash flows after its business has completely matured. In general, the long-run rate of inflation in Singapore, which is between 2% and 3%, can be a good proxy. I’d stick with 3% here.
With all the figures we have now, my number crunching results in the following implied growth rates in free cash flow for Singtel and Singapore Press Holdings over the next 10 years:
At Singtel’s current price of S$3.67, the market expects the telecommunications outfit to grow its free cash flows at a rate of 19.4% annually over the next five years and then by 9.7% per year for the next five. As for newspaper publisher and property developer Singapore Press Holdings, the two growth rates are 17.6% and 8.8%, respectively.
A Fool’s take
It’s important to note that a reverse-engineered DCF model is far from being a fool-proof method to think about a stock’s value. It comes with important problems, such as having the need for us to estimate the discount rate and terminal growth rate.
But, as mentioned earlier, a reverse-engineered DCF model is still very useful as it allows us to juxtapose the market’s expectations with our own assessment of a company’s ability to grow.
Coming back to Singtel and Singapore Press Holdings, do you think the implied free cash flow growth rates are reasonable? Let me know your thoughts in the comments section below!
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.